Why Coke, PepsiCo, and P&G Look Like Bargains

There’s a long list of grievances, including weak top-line growth, upstart competitors, less brand loyalty, rising costs (for trucking and aluminum, for instance), and a strengthening greenback.

But “that universal carnage is leaving opportunities,” asserts Jenny Van Leeuwen Harrington, CEO of Gilman Hill Asset Management. She adds, “I have never seen anything like this in consumer staples” since 2001, when she began managing an equity-income strategy.

With their massive cash flow, consumer-staples producers have long earned a reputation for covering and raising their dividends like clockwork.
Procter & Gamble
(ticker: PG), for one, has boosted its payout for 62 straight years.

Obviously, some of these stocks make sense for income-hungry investors. But a few also have at least mid-single-digit earnings growth ahead. Throw in the yields, and 10% one-year total returns are well within reach.

Within the sector, Morgan Stanley analyst Dara Mohsenian favors beverage makers over household-product outfits. Beverage firms, he says, have “superior pricing power” that’s “driven by greater channel diversity, less fragmented categories from a competitive standpoint, and lower private-label penetration.” And, he contends, “Large retailers are less likely to push beverage companies around as much.” Still, investors certainly have pushed
Coca-Cola
(KO) and
PepsiCo
(PEP) around, pummeling their stocks by 8% and 18% this year, respectively. But prospects look good for both.

PepsiCo is expected to increase earnings next year in the high-single-digit range, to $6.11, from an estimated $5.70 this year.

Pepsi has a more diversified product portfolio than Coke. More than 40% of its 2017 operating profit came from Frito-Lay North America, maker of Lay’s potato chips, Doritos, and other well-known brands. That unit has “the pricing and the scale to drive that much operating profit,” says Sonia Vora, a Morningstar analyst. She puts the stock’s fair value at $123; it was trading at nearly $98 recently.

The Frito-Lay division’s first-quarter organic sales grew 3%, year over year. A concern was its North American beverage unit, which generates roughly a third of PepsiCo revenue. Its organic sales dropped 2% on weaker volumes. The snack business, however, offers solid growth, “mainly because you have people eating more on the run,” says Mohsenian. As for health concerns, “consumers are very focused on sugar, but salt is less of a focus.”

Joseph Agnese, an analyst at CFRA, has a Strong Buy on the stock, with a 12-month price target of $120. He forecasts 2.7% organic revenue growth this year, better than 2.3% in 2017—with Frito-Lay North America being a big contributor.

Coke is much more of a direct play on beverages. However, it has been cutting costs, offering more innovative packaging (including sleeker cans and smaller bottles), and pushing healthier products. Its Zero Sugar brand of Coke had double-digit volume and revenue growth globally in the first quarter.

Coke has sold a lot of its bottling operations, which could make it less capital-intensive and help returns as it focuses more on selling concentrate. The sales should also “improve operating margins in the longer term,” observes CFRA’s Agnese.

The company expects to notch organic revenue growth this year of 4% and boost comparable earnings by 8% to 10%. Coke posted 5% organic revenue growth in the first quarter, in which it earned 47 cents a share, a penny better than it did a year earlier. Analysts expect Coke to earn $2.10 a share this year, about a 10% increase.

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Signature Coca-Cola drinks accounted for about 45% of worldwide unit case volume last year. But the company has numerous other brands, such as Dasani water and Minute Maid juices. This year, it rolled out Fuze Tea to 37 countries in western Europe. “Their distribution network is unrivaled,” says Morningstar’s Vora, who puts the stock’s fair value at $48.50, versus its recent price of $42 and change. “They have a presence in pretty much every country.” That distribution muscle should help the company boost its organic revenue growth by nearly 4% annually over the next three years, says Vora.

Last week,
Barclays
upgraded Coke to Overweight, with a $48 price target.

Procter & Gamble, the world’s largest maker of consumer packaged goods, is in a tougher spot. Fiscal third-quarter organic net sales rose only 1%, in part due to headwinds for razor-blade maker Gillette from Harry’s and Dollar Shave Club, even though volume was up 2%. In contrast, organic sales rose 5% at
P&G’s
beauty segment, which includes shampoo, and 3% at its fabric and home-care unit, which includes laundry detergents.

Wall Street sees mid-single digit profit growth this fiscal year, which ends in June, to $4.19 a share and to $4.47 next year.

Keith Snyder of CFRA expects acquisitions to help the top line. P&G is buying the consumer-health unit of
Merck KGaA
(MRK.Germany) for $4 billion. The deal will add “significant scale overseas,” says a recent Wells Fargo Securities note. The stock yields nearly 4%. Snyder has a Buy on P&G, with a price target of $100; the shares recently were near $74 and change.

It might take a little while for better top-line growth to materialize. But, says Snyder: “I don’t mind sitting on a 4% dividend yield waiting for that to happen.”

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